Brad Neuman: Avoiding the Behavioral Trap of Volatile Markets
With market volatility, investors’ most important task may be to make rational, thoughtful decisions about their portfolios while avoiding emotionally-based decisions that express ingrained biases in decision-making. Unfortunately, investors often make poorly timed investment decisions driving a negative performance gap of 137bps annually between their actual returns in mutual funds and reported fund total returns, according to data from Morningstar.i

We have previously written ​about potential strategies to make better decisions. A key component of our approach is to use the outside view. While many people use the inside view which is derived from a specific circumstance and uses evidence from one’s own experience, the outside view relies on data from comparable situations and utilizes evidence from others’ experiences. For example, if one were planning the construction of a house, the inside view would likely involve discussing a detailed plan with a contractor using explicit estimates. The outside view however would utilize comparable data of completed housing projects to determine a baseline estimate such as cost per square foot or time to complete construction. Once that data was aggregated, it would only then be adjusted by project-specific circumstances such as rockier land or more experienced builders.​​

Using the outside view, one can potentially glean insight on problems and pitfalls that may have been unknowable with only the inside view. In the construction example, it may be the case that in a typical 12-month project, a contractor typically has an emergency from another one of his or her clients that derails the project in question by approximately three weeks on average. That is something that would be very difficult to explicitly factor into a plan using the inside view, but is implicitly incorporated in the outside view using comparable data from others.​​

Rational, thoughtful decision-making is of course vital to successful investing. However, in our experience, many clients make fund allocations and other decisions based on inside views about where they see the stock market heading in the near-term or recent performance, driving redemptions often at inopportune times during periods of market stress. In fact, over two decades of data ​shows Alger Spectra performance has been unusually strong after periods of large net redemptions (2% or more of assets under management in a one-month period), with following median one- and three-year returns of 18.2% and 15.7% annually, beating the fund’s historical annual returns as well as its benchmark over the same periods. Therefore, the outside view shows that when investor angst is high, measured by redemption activity, strong returns are often just ahead. Interestingly, December 2018 was a large month of net outflows for the fund, and both the stock market and the Spectra fund have since rallied solidly.

So the next time you hear what appears to be a well-reasoned argument for making an investment decision that takes into account a wide array of current issues and trends, take a step back and ask to see the data from comparable situations and time periods. Looking outside of the specific situation in question is the first step on the path to making better decisions.​


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​​​​See Morningstar’s Mind the Gap 2018 study.



The views expressed are the views of Fred Alger Management, Inc. as of January 2019. These views are subject to change at any time and they do not guarantee the future performance of the markets, any security or any funds managed by Fred Alger Management, Inc. These views are not meant to provide investment advice and should not be considered a recommendation to purchase or sell securities.​

Risk Disclosure: Investing in the stock market involves gains and losses and may not be suitable for all investors. Investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. Many technology companies have limited operating histories and prices of these companies' securities have historically been more volatile than other securities, especially over the short term. Technology companies may also face increased competition, government regulation, and risk of obsolescence due to progress in technological developments.

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Before investing, carefully consider the Fund’s investment objective, risks, charges, and expenses. For a prospectus and summary prospectus containing this and other information or for the Fund’s most recent month-end performance data, visit www.alger.com, call (800) 992-3863 or consult your financial advisor. Read the prospectus and summary prospectus carefully before investing. Distributor: Fred Alger & Company, Incorporated. Member NYSE Euronext, SIPC. NOT FDIC INSURED. NOT BANK GUARANTEED. MAY LOSE VALUE.
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